DETOUR: AN ALTERED PATH TO PROFIT FOR EUROPEAN FINTECHS - MCKINSEY
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Global Banking & Securities
Detour: An altered path to
profit for European fintechs
To navigate the economic fall-out from COVID-19, Europe’s fintechs will need to
adjust their playbook.
by Chandana Asif, Max Flötotto, Tunde Olanrewaju, and Giuseppe Sofo
© Getty Images
September 2020Fintechs have been on a roll. Fueled by An altered path to profitable scale
generous amounts of venture capital funding,
last year 24 financial services startups hit a “It is only when the tide goes out that you discover
valuation of more than $1 billion, bringing the who’s been swimming naked.”
global total of such highly valued “unicorns” to – Warren Buffet
58. Together, these and other fintechs have
ushered in a revolution in customer experience: Fintech funding has slowed, and scarcity may
Consumers can now open an account or be with us for a while
get a loan in a matter of minutes (instead of In a matter of weeks, venture capital funding for
weeks or months), exchange and send money fintech companies went from surplus to scarcity.
internationally at low or no fees, and buy After growing more than 25 percent a year since
products with instantly created no-interest 2014, investment into the sector dropped by 11
installment plans. Fintechs have also upped percent globally and 30 percent in Europe in the
the ante for speed and agility, launching new first half of 2020, compared to the same period
features and initiatives in weeks instead of the in 2019.¹ In July 2020, after months of COVID-19-
six- to twelve-month timeframes more typical of related lockdowns in most European countries,
banks. the drop was even steeper—18 percent globally
and 44 percent in Europe, versus the previous
The emergence and spread of COVID-19—in the year (Exhibit 1).
first place a world health crisis—is also causing
unprecedented economic damage across the This constitutes a significant challenge for
globe. Most McKinsey COVID-19 scenarios show fintechs, many of which are still not profitable
European economies contracting by 11 percent in and have a continuous need for capital as they
2020 and not returning to pre-crisis levels until complete their innovation cycle: attracting new
2023. Fintechs are already feeling the squeeze. customers, refining propositions and ultimately
Venture capital funding has slowed, business monetizing their scale to turn a profit. The
model vulnerabilities are being exposed, and COVID-19 crisis has in effect shortened the
competitive dynamics are shifting. This has runway for many fintechs, posing an existential
brought the sector’s underlying profitability and threat to the sector.
long-term business model sustainability into
sharp focus—to a point where we believe the Analyzing fundraising data for the last three
path to profitable scale for many fintechs has years from Dealroom.co, we found that as
been structurally altered. much as €5.7 billion will be needed to sustain
the EU fintech sector through the second
This is not at all to write off the sector. Fintechs half of 2021 (Exhibit 2)—a point at which
have several long-term advantages—they are some sort of economic normalcy might begin
native to the digital arena, with more efficient to emerge. It is not clear where these funds
cost structures, organizational agility, and, most will come from. Fintechs are largely unable
importantly, higher customer loyalty. Consumers to access loan bailout schemes due to their
are now accustomed to quick, easy, low-cost pre-profit status. In addition, government-
financial transactions, and we believe there is backed wage support/furlough packages have
no going back. In this article, we explore how the income caps well below the typical salaries
dynamics for fintechs have changed (particularly of fintech engineers and other skilled talent,
in Europe), the opportunities and implications for which represent a large proportion of the fixed
financial services incumbents, and how fintechs costs of these businesses. While the VC and
can weather the storm. growth investment community will continue to
1
Dealroom.co data as of September 4, 2020.
2 Detour: An altered path to profit for European fintechsExhibit 1
Fintech fundinghas
Fintech funding has declined
declined bothboth in Europe
in Europe and globally.
and globally.
Global venture capital fintech funding and number of deals in H1 2019/2020 and Jul–Aug 2019/2020
Total funding
€ billion XX Number of deals
20 20
1,545
1,121
15 15
10 10
17.4
15.4
509
541 301
5 380 5
6.8 5.6
5.6 154
3.8 98
1.5
1.5 0.8
0 0
H1 2019 H1 2020 H1 2019 H1 2020 Jul–Aug Jul–Aug Jul–Aug Jul–Aug
2019 2020 2019 2020
Global Europe Global Europe
Source: Dealroom.co
back some companies, they cannot meet the 1. At-scale fintechs and some sub-sectors
aggregate demand on their own. European gaining disproportionately;
governments have stepped in to help, but they
too are only a stopgap. For instance, the UK 2. general downward pressure on valuations
created a coronavirus Future Fund to invest in (it’s a buyers market); and
growth sectors of the economy, of which £320
million has been dispersed to fintechs through a 3. increased relevance of incumbent/
convertible loan that matches funds raised from corporate investors.
venture investors. Germany and France have
also launched similar funds. Sub-sectors such as digital investments,
digital payments, and regtech, which have
Some fintechs are in the enviable position had tailwinds from crisis-related changes in
of having recently raised money or reached behavior, appear set to take a greater share of
profitability, and thus may be better able to the funding pie. For example, US-based retail
withstand a funding disruption. For others, we trading app Robinhood raised $200 million
see three likely funding effects emerging: in August 2020, increasing its valuation
Detour: An altered path to profit for European fintechs 3As much
Exhibit 2as €5.7 billion will be needed to sustain European fintech
through
As 2021.
much as €5.7 billion will be needed to sustain European fintech through 2021.
Distribution of fintech funding by year,¹ € billion
Seed Series A, B, C Series C+ Estimated funding needed through 2021²
Seed Series Series Total
A, B, C C+
2018 0.46 1.52 0.89 2.86 0.5 1.5 0.9 2.9
2019 0.58 2.49 2.63 5.70 0.3 1.2 1.3 2.9
H1 1.89 1.56 3.69 - - - -
2020
0.24
Total 0.8 2.8 2.2 5.7
¹Funding last raised in respective years 2018, 2019, 2020.
²Numbers may not sum due to rounding.
Source: Dealroom.co, data as of September 4, 2020
from $8.6 billion in July 2020 to $11.2 billion. In under pressure as the broader economy slows
addition, there appears to be a surge in corporate down. As a result, Western European retail
and incumbent activity. For example, American banking revenues after risk could drop by 35 to
Express recently acquired US-based Kabbage, 40 percent as risk costs rise (by 4-6 times) and
a fintech that offers credit and cashflow net interest margins decline due to persistent low
management solutions to SMEs. interest rates.²
Business model vulnerabilities Take digital banks as an example. Even before
Although fintechs offer a different customer the COVID-19 crisis, their challenges in getting
value proposition than incumbent banks, they to profitable scale were non-trivial. On average,
are still subject to the same economics as the customers at digital banks hold 1.5 products, as
broader banking sector. The COVID-19 pandemic compared to 5 for traditional banks, according
is expected to have a significant negative impact to a 2018 McKinsey survey.³ In addition, digital
on overall industry profitability (Exhibit 3). As banks rely on transaction fees and commissions
household incomes decline and discretionary for the bulk of their revenues, and only a few have
spending drops, European transaction volumes been successful in having customers sign up for
and value could decrease by 10 percent for a subscription/account fee. Incumbent banks, on
domestic transactions and 25 percent for cross- the other hand, generate income from multiple
border transactions. Loan volumes are also sources beyond transaction fees—including
2
Based on the A1 scenario introduced in “Safeguarding our lives and our livelihoods: The imperative of our time,” McKinsey & Company, March
2020, McKinsey.com. Numbers updated as of April 23, 2020.
3
McKinsey Open Banking Survey; figures include individual products (e.g., multiple credit cards and savings accounts).
4 Detour: An altered path to profit for European fintechsExhibit 3
Fintechs will not be immune to the negative impact of COVID-19 on banking.
Fintechs will not be immune to the negative impact of COVID-19 on banking.
‘Lost’ revenue1 between ‘muted recovery’ (A1)2 scenario from pre-COVID-19 forecasts;3
sum of Germany, UK, France, Italy, and Spain, 2020–25
Short-term impact (2020-21) Medium-term impact (2022-23) After effects (2024-25)
Increase in corporate Continued low debt/ Corporate debt/
and consumer loan profit ratio and profit ratio remains
defaults low profits under strain
Risk Continued high loan-
to-income ratios
Decline in consumer Lower demand for Subdued demand
lending and personal retail lending for corporate and
financial assets Loss of demand for SME lending
Volume Drop in payments corporate (and
volumes SME) loans and less
Increase in corporate build up of corporate
credit lines and deposits
deposit as buffer
Payments fee Lower deposit Continued pressure
compression (FX, margins from lower on interest margins
shift online) structural hedges
Margin Increase in lending Lower wealth
margins (risk is advisory fee (shift
priced in new loans) towards safer assets)
1
Retail and corporate banking revenues; does not include capital markets revenues.
2"Safeguarding our lives and our livelihoods: The imperative of our time," McKinsey.com, March 23, 2020.
3Comparison of the decline in revenues vis-à-vis pre-COVID-19 forecasts (2023 pre-COVID-19 forecasts less 2023 forecasts under “muted recovery” scenario)
Source: MGI; McKinsey PFIC – Global Banking Pools
packaged accounts, commercial and consumer to €50–€200). Fintechs that are skewed
credit products, mortgages, and investments. towards customer acquisition (as opposed to
As a result, many digital banks have a cash- driving positive unit economics) are particularly
consumptive business model that requires challenged. Given the contracted funding
continual investor funding. Pre-COVID-19, their environment, many digital banks cannot sustain a
loss per customer was between €10 and €60. cash consumptive business model in the medium
(Top-performing incumbent banks, on the other term. Instead, a laser-sharp focus on expanding
hand, generated €150 to €350 per customer) their revenue engines, coupled with a shift in
(Exhibit 4). Now, fintechs’ loss per customer is customer acquisition strategy to pursue more
expected to expand to €20 to €75 (and profit economically viable segments, will be required.
per customer at top incumbent banks to drop
Detour: An altered path to profit for European fintechs 5Pre-COVID-19:
Exhibit 4 European digital banks faced challenges compared to
incumbent banks.
Pre-COVID-19: European digital banks faced challenges compared to incumbent banks.
Profit per customer, €
Top incumbent bank1 Top digital bank3
Valuation per customer: €550 to €575
50 –250
500 to 60 to –300
to 600
Non-
interest
–50 to
income
–100
Operating 150 to 350²
costs
Impairments Profit
gap of
–45 to €200 to
~5 10 to 15 –50 –30 to –40² €400 per
~–5 customer
Net Profits Net Non- Operating Profits
interest before interest interest costs before
income tax income income Impairments tax
1
Based on average economics of top Western European incumbent banks’ retail banking segment for FY2019.
²Numbers may not sum due to rounding.
3
Based on average economics of top Western European digital banks available pre-COVID-19.
Source: McKinsey research and analysis
The pandemic has also severely impacted acquired by UK challenger bank, Metro for up
monoline businesses such as peer-to-peer to £12 million, pending approval) requested
(P2P) lending and marketplace financing. These a payment freeze, causing the company to
businesses match borrowers and lenders, halve its interest payouts (from 3 to 4 percent
earning the difference between the interest to 1.5 to 2 percent) and increase the size of its
charged to borrowers and the funds returned Provision Fund (which serves as a buffer to cover
to the lender. Until the first quarter of this year, missed payments from borrowers). In the long
these companies relied on cheap funding, a term, the resilience of this business model will
surplus of low-credit-risk borrowers, and highly depend heavily on how the sector adapts its
automated operations to make their economics risk management practices and addresses its
work. Higher post-COVID-19 credit risk (a four- to funding challenges. In particular, many of these
six-fold increase) now requires the recalibration companies will have to navigate conduct and
of underwriting standards and the build-out of compliance issues through what will be their first
collections capabilities. Many P2P platforms, real experience of a negative credit cycle.
required by regulation to grant COVID-19 payment
holidays to borrowers, have had to reduce their Finally, B2B fintechs, which sell services
interest payouts in order to increase the amount and technology to financial institutions, are
of their “loss absorbing” funds. For instance, grappling with increasingly challenging selling
in May 2020 it was reported that 6 percent of environments. Now more wary of upfront costs
borrowers at UK-based RateSetter (recently and multi-year commitments that won’t pay off
6 Detour: An altered path to profit for European fintechsquickly, 40 percent of large financial institutions Adjusting the playbook: Four
said they are conducting a more detailed ROI actions to consider
analysis before making purchase decisions.
Fintechs that help financial institutions rapidly “You’ve got to know when to hold ’em, know
digitize, automate, and reduce their costs are the when to fold ’em, know when to walk away,
most likely to continue to get attention and win know when to run.”
sales. Those providing end-customer capabilities, – Kenny Rogers
such as dashboards and visualization
components, may now be viewed as a “nice to The demand for quick, easy, low-cost financial
have” purchase for financial institutions. transactions isn’t going away. If anything,
the crisis-fueled shift to digital channels
Changing competitive landscape is accelerating the demand—and fintechs
Today’s new economics are likely to prompt a may be in a better position than incumbents
wave of consolidation. With fintechs at lower to respond. Between 5 and 20 percent of
valuations, incumbent banks and other corporate consumers in Western Europe say they
players have a rare opportunity to enter new areas expect to do more digital banking. As many
or gain access to proven talent and technology. as 80 percent of consumers in these markets
For example, JPMorgan partnered with Taulia, a say they prefer to handle everyday financial
California fintech, to develop customized trading transactions, such as checking balances and
solutions for customers. Making these fintech/ money transfers, digitally. This is true even for
incumbent unions work can be notoriously consumers in the over-65 age segment.⁴
difficult—superior execution will be critical.
The issue is not whether fintechs persist, but
Acquisitions are also likely to occur amongst rather which will survive. We have identified
fintechs. Many already leverage each other’s four emerging imperatives that all stakeholders
capabilities (for example, many fintechs use other in the sector—from fintechs and investors to
fintechs like OnFido and Jumio to support KYC incumbent banks and corporate partners—
diligence), but we see potential for even more should pay attention to.
ambitious combinations. Synergetic fintechs
could merge to quickly fill monetization gaps 1. Targeted retrenchment combined with
in their business models. A fintech with a large big bets
transactional customer base but no lending With core economics challenged and capital
capability, for instance, might acquire credit sparse, it is obvious that many fintechs will
expertise and the relevant technology in order to have to retrench thoughtfully if they want
offer a broader customer value proposition. to avoid burning money unsustainably and
spending themselves out of business. This
At-scale and mature fintechs will get the biggest will mean trimming international expansion
benefit, as competitors consolidate, weaken, plans, business lines, products, and initiatives.
or simply go out of business. The current Fintechs have to focus their energies and
environment offers a window for successful and capital on areas where they can truly make a
profitable fintechs to supplant competitors with difference—and do so quickly. Importantly, this
targeted offers and competitive pricing at a time entails not just cutting back, but also placing
when customers are more likely to be open to bigger bets and directing leadership attention
alternatives. These companies are also likely to to areas with long-term potential. London-
continue to attract capital. based Revolut, for example, in addition to
4
McKinsey Financial Decision Maker Pulse Survey; run in early April 2020; countries surveyed include UK, France, Italy, Spain, Germany and
Sweden (1,000 representative consumers each).
Detour: An altered path to profit for European fintechs 7taking steps to adjust its cost base has also technology, which will allow them to digitally
indicated it is looking at inorganic options in the onboard new customers without increasing their
travel space. anti-money laundering risk exposure.
2. Leaning into next-normal behaviors 3. Business model course corrections
The ability to rapidly respond to changing The potent combination of changing customer
customer needs is one of the hallmarks of buying and consumption patterns, a weaker
the fintech industry. COVID-19 has brought economy, lower interest rates, and reduced
digital payments, digital onboarding and virtual creditworthiness represents a fundamental
customer service to the forefront. Players challenge to many fintechs’ business models.
now need to take a hard look at their value Company leaders need to take a hard look at
propositions and roadmaps and ensure that their economic model and make adjustments,
they reflect evolving customer behaviors while preserving the best aspects.
and segments, testing and validating new
propositions at pace. For some fintechs, this For instance, digital banks still have the
will mean helping governments meet the advantage of no physical footprint, flexible,
unprecedented demand to provide fiscal modular technology, and an agile operating
relief to citizens and to distribute these funds model. We estimate that these business model
appropriately and quickly. In the UK, OakNorth, advantages coupled with robust monetization
Starling, and Funding Circle, among other strategies can yield a net incremental pre-tax
fintechs, pivoted quickly to become approved profit of €60 to €100 per customer, which would
lenders for the Coronavirus Interruption Loan be in line with current valuation per customer
Scheme. In Italy, payments providers Soldo (Exhibit 5). Our analysis shows that about 50
and Satispay were the only fintechs selected percent of this incremental value will likely
by the City of Milan as preferred channels for come from credit-related propositions, with
distributing government aid to people who qualify. a further roughly 30 percent from thoughtful
introduction of subscriptions and product fees.
B2B fintechs also have an opportunity to meet As an example, UK digital bank Monzo launched
new needs. OakNorth, a lender for small and its “Plus” account at £5 a month, offering
medium-sized companies, sold its platform to two customers interest, no fees on international ATM
large US banks to help them analyze and monitor withdrawals, and a dashboard view of other bank
the impact COVID-19 is having on individual loans accounts and credit cards.
and to automate the customer journey for small
businesses applying for and receiving Paycheck B2B fintechs, which are contending with longer
Protection Program loans. sales cycles and more cost-conscious buyers,
would do well to revisit their pricing structure.
There is also an opportunity for B2C companies to Given the relatively fixed nature of their costs,
expand into B2B markets. UK-based OpenWrks’s offering customers a product trial approach with
spinoff Tully launched a payment relief portal lower upfront costs and considering shifting
that allows consumers to claim bill payment from their current license-based pricing model to
suspensions from more than 50 UK banks, credit a usage-based one could unlock opportunities
card companies, building societies, and energy without damaging long-term economics.
companies. Digital banks might also consider
white-labelling their technology platforms and 4. Fueling growth through M&A and joint
digital capabilities for incumbent banks that are ventures
in dire need of rapid digitization. With so many Many of the key actions fintechs want to take—
of their employees working remotely, financial such as launching new features, building new
institutions have a greater need for paperless capabilities, or pivoting toward new revenue
customer verification and enhanced KYC streams and segments—could be achieved
8 Detour: An altered path to profit for European fintechsExhibit 5
Digitalbanks
Digital banksneed
need to increase
to increase profitprofit per customer
per customer by€100
by €60 to €60totoachieve
€100 to achieve
valuationcomparable
valuation comparable to industry.
to industry.
Profit per customer at top digital banks, €
Average across digital banks, 2020 estimate1 Implied level to meet valuations2
Net interest income Non-interest income Operating costs Impairments Profits before tax
50 to 60
45 to 50
20 to 45
~6 to 7x
15 to 16x
~€60 to €100
gap to meet
6 to 11 valuation²
3 to 4
~–10
–10 to –15
~25% increase
as more lending begins
–45 to –50 ~–40 to –50
–55 to –60
1
COVID-19 impact estimated based on McKinsey A1 (“muted recovery”); adjusted for H1 2020 results of major banks.
²Profit estimated based on digital banks reaching a P/E ratio between 10x (avg. WE banking multiple as of August 2020) and 20x. NII and other income have
been proportioned according to Scandinavian banks (NII: 45%; other income: 55%). Based on current valuation of €400 to €450 per customer.
Source: Company reports, Press, Panorama Global Banking Pools, McKinsey Analysis
more rapidly through thoughtful acquisition or meet lending criteria for different loan types.
partnerships than by organic development. Three As previously mentioned, the UK’s Metro Bank is
areas stand out as likely to see higher activity: in the process of acquiring marketplace lender
next-generation credit capabilities, open data, and RateSetter, in an effort to bring RateSetter’s
distribution collaboration. technology, talent, and skills quickly to its
customers. Fintechs, particularly those that are
The pandemic has upended many manual credit centered around transactional products, would
processes and credit-scoring models, creating do well to look at such routes to accelerate their
a need for new approaches. Many incumbents/ credit capabilities.
corporates are turning to fintechs to meet this
challenge. Lending marketplace FundingXchange, With the advancement of open banking/PSD2,
together with credit bureau Experian, launched a the use of open data to help customers and
B2B service to help lenders assess whether SMEs institutions make better financial decisions will
Detour: An altered path to profit for European fintechs 9grow. For instance, the ability to overlay COVID- Embracing the new reality with pace
19 scenarios at the borrower P&L line-item level and agility
to predict expenditure, or drive early-warning
systems using real-time transaction data from “In the new world, it is not the big fish that eats the
open banking, will be valuable capabilities. small fish, it is the fast fish that eats the slow fish.”
Mastercard, for example, is in the process – Klaus Schwab
of acquiring data aggregator Finicity, which
uses consumers’ financial data to help banks Fintechs have had an undeniably positive effect
speed up credit decisions and improve account on the range of financial products available and
verification processes. Visa’s acquisition of Plaid, have ushered in a new sense of possibility for the
whose API software lets third parties like Venmo industry. As is often the case with innovations,
connect to users’ bank accounts, allows Visa the original creators may not persist but their
to expand beyond its core payments business. new ways of doing things often do. As more
Given that such data capabilities are likely to incumbents struggle to adapt, the winners will be
become table stakes in the future, securing those that quickly recognize the changed context
relevant assets should be a priority now. and that are most capable of responding with
clear decisions and bold actions.
If executed successfully, partnering with
or acquiring players with complementary or Many organizations, both incumbents and start-
adjacent propositions serving the same end ups, have adapted with surprising quickness and
customer is almost always advantageous. rapid decision making through the COVID-19
Distribution synergies and/or proposition crisis. This new sense of possibility and potential
expansion can cost-effectively increase value should inform future action. Whilst there will
per customer and loyalty. We believe the current undoubtedly be challenging times ahead, speed
crisis has opened up new opportunities for the and a willingness to challenge orthodoxies are
acquisition/partnership approach. For instance, necessary to thrive. Fintech companies have
Tide, a UK-based digital bank, teamed up with shown great potential for transformative impact—
insurance solutions provider Hokodo to launch now is the time to fulfill that promise.
a new invoice-protection product for SMEs.
During the UK’s lockdown, Swedish mobile
POS manufacturer iZettle partnered with last-
mile delivery company Stuart to offer a remote
payment and courier service to small businesses
without an ecommerce presence, allowing these
businesses to sell digitally.
Chandana Asif is a partner, Tunde Olanrewaju is a senior partner, and Giuseppe Sofo is a consultant, all in McKinsey’s
London office. Max Flötotto is a senior partner in the Munich office.
The authors would like to thank Alessio Botta, Raghav Didwania, Jeff Galvin, Divya Gogna, André Jerenz, Benjamin Köck,
Alexis Krivkovich, Nikki Shah, Arthur Shek, Kriti Suman, and Daria Vakhina for their contributions to this article.
Copyright © 2020 McKinsey & Company. All rights reserved.
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